What are some common mistakes in refinancing?

The promise of a smaller monthly mortgage payment makes many people quick to start a refinance—but approaching the process with understanding and being prepared will help you to avoid the most common pitfalls, which include:

•   Not doing a break­even analysis. Determine the total cost of the transaction and calculate how much you will save every month. Divide the total cost by the monthly savings to find the number of months you will have to stay in the property to break even. For example, if your transaction costs $2,000 and you save $50/month, you break even in 2000/50 = 40 months. In this case, you'd refinance if you planned to stay in your home for at least 40 months.

Note: This is a simplified break­even analysis. If you are considering switching from an adjustable to a fixed loan, or from a 30­-year loan to a 15­-year loan, the analysis becomes much more complex.

•   Not getting a written Good Faith estimate of closing costs. Within 72 hours of submitting an application, the lender is required by law to disclose completed Good Faith Estimate and Truth In Lending Disclosure forms. Be sure these documents are made available to you and review them closely.

•   Signing your loan documents without reviewing them. Whenever possible, review in advance the documents you'll be signing. It's unlikely that you'll have sufficient time to read all the documents during the closing appointment.

What does the term "Buying Down" mean?

The term "Buying Down" the rate refers to the paying of discount points to obtain a lower interest rate. A discount point is one percent of the loan. For example, if you were charged one discount point on a $100,000 loan you would pay $1,000. A simple way of figuring out whether or not you should pay discount points requires an easy mathematical calculation: Divide the difference of the cost of discount points on two loans by the difference in the payment. If you'll be keeping the loan longer than the number of months indicated, the payment of the discount points is mathematically warranted. Use this rule of thumb: If you plan to stay in the house for less than 3 years, do not pay points. If you plan to stay in the house for more than 5 years, pay 1 to 2 points. If you plan to stay in the house for between 3 and 5 years, it does not make a significant difference whether you pay points or not.

What is PMI?

PMI stands for Private Mortgage Insurance. PMI is usually required when you buy a house with less than 20% down. Mortgage insurance protects lenders against the costs of foreclosure and is provided by private mortgage insurance companies. It also enables lenders to accept lower down payments than they would normally accept. Without mortgage insurance, you might not be able to buy a home without a 20% down payment. The lower your down payment, the higher your PMI. Your PMI premium is usually added to your monthly mortgage payment. Can I get rid of the PMI on my loan? Some lenders may require you pay PMI for one to two years before allowing you to apply to remove it. You can also cancel your PMI by refinancing and obtaining a new loan without PMI.

Should I refinance?

The most common reason people refinance is to save money. They are saving money by obtaining a lower interest rate, causing their monthly mortgage payment to be reduced, or by reducing the term of the loan, thus saving money over the life of the loan. People also refinance to consolidate debts and replace high­ interest loans with a low-rate mortgage. The debts being consolidated may include credit lines, credit cards, second mortgages, student loans, etc. In many cases, a debt consolidation results in tax savings, because consumer loans are not tax deductible, but a mortgage loan is tax deductible.

Another reason people refinance is to convert their adjustable loan to a fixed loan. The main reason behind this type of refinance is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments.

What is a FICO score?

A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring is a method of determining the likelihood that credit users will pay their bills. A credit score attempts to condense a borrower’s credit history into a single number. Credit scores are calculated by using scoring models and mathematical tables that assign points for different pieces of information which best predict future credit performance. Credit­bureau models are developed from information in consumer credit ­bureau reports. A borrower's credit score is calculated using numerous factors of their credit history, including:

  • Late payments
  • The amount of time credit has been established
  • The amount of credit used versus the amount of credit available
  • Length of time at present residence
  • Employment history
  • Negative credit information such as bankruptcies, charge­offs, collections, etc.

The three credit bureaus used are

  • Equifax 1-­800-­685-­1111
  • Trans Union 1­-800­-916-­8800
  • Experian 1­-888-­397-­3742

Some lenders use one of these three scores, while other lenders obtain scores from all three bureaus and use the middle score. If you see an error on your report, report it to the credit bureau. They each have procedures for correcting information promptly.

Have questions about refinancing or applying for a home loan? Call 1-800-­806-­6045 today for a free consultation or